Here’s what businesses need to know before leaving California

Businesses have long chosen to be headquartered in California over other states. But since 2018, many large corporations have moved their headquarters overseas, including Tesla, Oracle and Nestle. The change is undoubtedly driven, at least in part, by the state’s expensive cost of living, high taxes and complex regulatory environment.

While large corporations have the legal resources to navigate moving elsewhere, small businesses are often left asking: What does it take to leave California? This article outlines five key steps to moving your business from the Golden State.

Informing the Franchise Tax Board and the IRS

In general, moving operations outside of California shields your business income from California income taxes. However, the California Franchise Tax Board may be able to tax at least a portion of this income if the business is registered in California, its income is derived from sales or services within the state, or the legal entity is an entity tax conduit. goals (e.ga partnership) and the resulting pass-through income is recognized by one of the California-based business owners.

Moving operations are necessary to “leave” the state for income tax purposes, but more is required. Technically, the business will remain subject to California income tax if it continues to be “actively engaged[e] in any transaction for the purpose of financial gain…” in California.”

Then, remember that the business is no longer subject to California tax. To complete your California business tax status, you must file any outstanding California tax returns; pay all outstanding balances, fees and interest; and then file your final California business tax return. Be sure to check the “final return” box and write “final” at the top of the first page. Remember that this will not bypass California taxes on California generated income or any income for California resident business owners.

Be sure to inform the IRS of your new address, as failure to do so may result in lost correspondence. You can inform the IRS by including your new address on your next business tax return. If it’s early in the tax year, notify the IRS at the same time you file your California tax returns by filing IRS Form 8822-B.

Converting, merging or transferring your business

Closing a California business is relatively easy—when you’re ready, you simply cease its legal existence in California and “cease” operations within the state. The closing process mainly depends on the form of the economic entity. Sole proprietorships and general partnerships do not need to register with the California secretary of state upon formation, so they do not need to file anything with the SOS to close. Corporations, limited partnerships, limited liability partnerships and limited liability companies are registered with SOS after formation, so they must submit dissolution (corporations) or cancellation (LLCs and partnerships) forms. Do this by submitting a closing form with SOS within 12 months of filing your last business year’s tax return. If you have suspended your business, you must first revive it before you can distribute it. Do this by filing a revival request.

Moving a business outside of California for legal purposes is a bit more difficult. The three main methods are to convert the California entity into an entity organized under the laws of your new state; merging the California entity into a new entity organized under the laws of your new state; and, less commonly, transferring business assets to a new entity organized under the laws of your new state.

Conversion is often simpler, but is limited to certain business forms. LLCs, LPs, and GPs can convert to a foreign business entity—corporations cannot. A merger requires a bit more paperwork, including forming an entity in the new home state and filing a certificate of incorporation with the new state’s SOS. Transferring assets involves the most work because it requires the preparation of documents to memorialize the transfer of each asset.

Before converting, merging or transferring assets, make sure the lawyer confirms that this will not inadvertently violate, terminate or adversely affect existing agreements. Some of your contracts may include anti-assignment or change-of-control provisions that will be triggered, including vendor and customer contracts, as well as loan and lease agreements. This concern applies primarily to transfers of business assets to a new entity and is especially problematic during our current high-inflation environment—you may end up renegotiating with vendors for the same services or supplies at a higher price. State statutes often make anti-assignment provisions inapplicable to conversions and certain types of mergers. California has such statutes, but be sure to confirm with counsel that they apply to your situation.

Registration as a foreign entity in California

Whether you convert, merge, or transfer your assets to a new entity, if you plan to continue doing business in California, you should consider registering as a foreign entity there (or to use the correct word, qualify). Many worry about this strategic business decision, and with good reason. California’s rules regarding foreign qualification are unclear and registration may attract undue attention from the California Franchise Tax Board.

uncertainty. Generally, a business must be registered if it “transacts[s] interstate business” in California. The term “intrastate business transaction” is defined as “entering into repeated and successive transactions” in California. There are specific questions of fact to consider based on the in-state activities of the business and unexpected statutory exceptions (eg, owning stock in another company that conducts in-state business transactions). But after a deep dive, you’re often still left without much clarity.

Penalties. Failure to register results in a $20 daily fine. Just as important, until the business pays its fines plus an additional $250, it cannot effectively sue others for the underlying claims in California state courts. Also, any person knowingly involved is subject to a misdemeanor charge that carries a fine of up to $600.

The biggest penalty stems from a business’s failure to comply with California’s tax rules, not its registration rules. As noted above, a business that engages in transactions in California may still be taxable in California. Not only does this result in California taxation, but failure to file and pay may also result in penalties (eg, $2,000 annual failure-to-file penalty) plus interest on unpaid taxes that accrues at 5% per month ( up to 25%).

Franchise board marking. In deciding whether to register, a major concern of many businesses is that registration increases the possibility of attention from the California Franchise Tax Board. Registration automatically requires a business to file a California tax return. Even if the business would not otherwise owe California income tax, registration triggers a filing requirement, a minimum tax liability of $800 and unwanted monitoring.

Registration of Licenses and Permits

Nearly 75% of businesses in the US are sole proprietorships. Although they do not need to register with SOS, they are subject to most of the same licensing and permit requirements as other businesses. These include building permits, zoning and land use permits, health permits, public safety permits, occupational licenses, sales tax licenses, and home business licenses. Even if your business is exempt, licenses can often provide access to financing and limit the owners’ personal liability. After closing your business, be sure to cancel all state and local business licenses and permits. Failure to do so may result in a trail of documents, communications and additional fees.

Knowing the employment laws in the new state

Employment law is a beast of its own, so be prepared for changes in the rules wherever you go. California generally voids employment non-compete agreements and non-compete clauses in other employment-related agreements. On the other hand, Texas and Nevada—two of the top destinations for former California businesses—generally enforce non-compete employment if the restrictions are reasonable in time, geography and scope of activity. You should check the new rules that your business will have to follow.

Moving a business is hard. But it may be harder to ignore the potential benefits of lower taxes, cheaper living and a more permissive regulatory environment. The realities are enough to give any business owner pause. If you decide to leave, be ready to take these steps.

This article does not necessarily reflect the opinion of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Information about the author

Sergio Broholm is an associate in the Corporate group at Shartsis Friese. He focuses on mergers and acquisitions, emerging companies and general contractual and transactional matters.

Jack Frisbie is a law student at USC (’23) and a summer associate at Kirkland & Ellis. Since working as a Treasury analyst at Belk, he has focused on law and business strategy.

Jeremy Babener is the founder of Structured Consulting and previously served in the US Treasury’s Office of Tax Policy. He consults for businesses on strategy, partnerships and marketing.

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